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Wednesday, December 31, 2014

As we noted around Christmas, certain days of the year are dead news days, particularly with regard to news related to UC and UCLA. New Year's Eve is one of those days. The university is essentially shut, except for the hospitals. (And, if you can avoid it, you might want to delay getting sick.)All of that being the case, the blog wishes you a Happy New Year. But the link below about a fellow named Tobias (absolutely unrelated to the leader of the UCLA Faculty Association - Tobias Higbie - we hasten to add) will remind you not to get too excited about the prospects for next year:

You may have noticed the article in the LA Times about the decision of the president of the University of Alabama-Birmingham (UAB) - amid much controversy - to end its football program. Buried in the article is this reference to the litigation and related changes we have noted in prior postings that generally move to recognize such college sports as essentially commercial operations hooked to a university:

...According to a yearlong strategic planning report commissioned by UAB,
the university not only subsidizes two-thirds of the $30-million annual
athletic department operating budget, but also faces rising costs as the
NCAA loosens its rules to allow schools to offer financial compensation
for athletes. The school would need to invest an additional $49 million
in football over the next five years to remain competitive in
Conference USA, the report said...

Tuesday, December 30, 2014

California judges sue CalPERS pension system over contributions

(Reuters) - A group of judges is suing California's public pension
system CalPERS and the state of California over claims their pension
contributions have been almost doubled unlawfully. Under state pay grades, the six California Superior Court judges each
earn more than $181,000 a year. The lawsuit filed on Dec. 23 says their
pension contributions should be lowered by about $13,000 a year. The six, who were elected in 2012, claim a pension reform law signed
by Governor Jerry Brown which took effect Jan. 1, 2013 has raised their
pension contributions to 15 percent from 8 percent of their salary. They
say the 8 percent contribution was set in stone and should not have
been raised by the new law retrospectively...

There is good news and bad news in the item above for the UC pension. Despite news stories suggesting that court decisions will allow substantial retroactive cutbacks in public defined-benefit pensions, it is worth noting that the judges who might make those decisions are themselves covered by those very plans. As the item suggests, they tend to take the view that a promise is an ironclad promise. On the other hand, the "optics" (as they say) of high-paid employees complaining is never good PR.

As blog readers will know, the UC pension's funding plan assumes that the portfolio over the long term will earn 7.5% per annum. Other California public pension plans assume similar earnings. Critics, however, argue that while such earnings might have characterized the past, rates of return will be lower in the future. If you assume a lower rate of return, the liabilities (and unfunded liabilities) of the pension loom larger than official estimates.

However, the returns needed for any given defined-benefit pension plan depend on the assumed outflow of funds which in turn depends in part on future inflation as reflected in the salaries on which future pensions are based and on inflation-linked escalator features, if any, in the plan that adjust benefits for price increases. (The UC plan has a complicated partial price adjustment escalator.) Read on:

In past musings, we
have noted that there is a group of monetarist-oriented economists who are
convinced that the fact that the Federal Reserve greatly increased its lending
in various ways during and in the aftermath of the Great Recession means a
Great Inflation is on the way.So far,
however, that inflation has yet to appear, as the chart below indicates.Although inflation has varied, as measured by
the "core" Consumer Price Index (which excludes the volatile food and
energy sectors), no Great Inflation is evident.

----------------------------

Source: U.S. Bureau of Labor Statistics.

-----------------------------

Some Great Inflationists
have suggested in response to the official numbers that the CPI is being rigged
to hide inflation.There is some irony
in that charge since to the extent there have been modifications of the CPI
methodology, they came largely in response to criticisms by many of the same
folks who argued in the 1990s that the CPI exaggerated the inflation rate.Apart from that historical detail, their
estimate of the exaggeration was around 1 percentage point per annum, so any
estimates of the effect of the modifications are upper-bounded by that
limit.In short, you can't make a case
for a hidden Great Inflation based on recent changes in CPI methodology.

Of course, what has
happened to inflation so far does not
necessarily indicate what could
happen in the future.An interesting
question is what financial markets expect the trend in inflation to be.One measure we have cited in prior musings is
the yield spread between conventional Treasury securities and Treasury
securities that are adjusted to the CPI - so-called TIPS.You can see the yield spreads below and they are
not suggesting any forthcoming Great Inflation. Indeed, for the last six
months, inflation expectations have been diving.[1]

Now there is no guarantee
that the implicit inflation forecast by financial markets will come true.Indeed, the Great Recession was a Great
Illustration of the fallibility of such markets.But what if something like the implicit
forecast turns out to be accurate and the inflation rate – as measured by the
CPI – turns out to be something like, say, 2% per annum over the long term?

There would be implications
of such a development for macroeconomic policy which is partially aimed at
keeping inflation low.But a neglected area in the inflation outlook
is the implication for defined-benefit pension plans, nowadays mainly found in
the public sector.Such plans
provide a pension based on a formula linked to the earnings history of the
employee.A trust fund is supposed to
hold sufficient assets, derived from employer and employee contributions and
past earnings on the portfolio, to pay those benefits.Particularly in the aftermath of the Great
Recession and the related drop in the stock market that accompanied it, those
plans tended to be underfunded.

When actuaries calculate
funding ratios for pension plans, they make assumptions about inflation.Inflation is assumed to affect future wage
growth of employees and thus will affect their eventual pensions, typically
based on some version of end-of-career earnings.In some cases, there may also be partial or
full inflation adjustments to the pensions themselves after retirement.Each plan has its own formulas so the impact
of assuming more or less inflation will vary.

In calculating the funding
ratio of a pension plan, actuaries use an assumption of the expected earnings
over the long term of the trust fund portfolio.Typically, the assumption is expressed in nominal, not real, terms.A common assumption nowadays is a nominal
return of around 7.5% per annum.Critics
of such assumptions argue that numbers like 7.5% are too high. While portfolios might have seen such
long-term earnings before the Great Recession, we are now, they say, in a “new
normal” of lower returns.Therefore, the
argument goes, estimates of pension underfunding are too low.Maybe the long-term rate of earnings will be
only 6.5% or less and not 7.5%.

The impact of a lower actual
nominal earnings rate on the funding ratio will vary from plan to plan.But to illustrate the impact, consider a
promise to pay $1 per year, adjusted for
future inflation, “forever.”Suppose, in addition, you thought the inflation rate over the long term
(forever) would be 3%.If you wanted to
set aside enough today to meet that commitment (100% funding) and thought you
could earn 7.5% per annum, you would need to set aside about $23.[2]But if you thought you could earn only 6.5%,
you would need over $29, i.e., roughly a fourth more.The lower the rate you expect to earn in
nominal terms, given an assumed rate of
inflation, the greater is your liability.(If you could earn only 3% - so your real rate of earnings was zero –
your liability would be infinite since it goes on forever.)

Suppose, however, your
expectation of inflation dropped, say, from the 3% per annum of the previous
example to 2%.Essentially, your
required earning would drop by the same amount in this story.So with 2% inflation, nominal long-term
earnings of 6.5% would produce about the same $23 liability that 7.5% earnings
with 3% inflation gave you before.

The bottom line here is that
even if defined-benefit pension trustees have been over-optimistic about assumed
future nominal earnings, if inflation over the long term will be less than they
expect, they in fact won’t need as high a nominal earnings rate as they have
anticipated.Put another way, if you
argue for lowering the assumed nominal earnings rate for a pension plan because
we are in a “new normal” of lower stock market gains, you have to consider
whether you should also be lowering your assumption of future inflation.A “new normal” of lower inflation tends to
offset a new normal of lower nominal earnings.

Monday, December 29, 2014

Yours truly sent a correction on Nov. 29 to the LA Times concerning an editorial cartoon shortly after the November Regents meeting (and then forgot to follow up to see if the correction had been made). As it turned out, it had. The original version of the cartoon indicated the Regents had granted themselves big pay raises while voting for tuition increases. But the Regents aren't paid salaries and didn't vote themselves anything. Below is the original:

And here is the corrected version:

Whether that correction is a PR victory, I'll leave to others to determine. However, the LA Times today is running an editorial characterizing the tuition/state funding proposal of UC prez Napolitano and the Regents as a bold move:

...Napolitano was a surprise choice for UC president because she lacked the
traditional academic background. But her strategic skill and political
instincts have enabled her to pull off a bold act of brinkmanship.
Because of it, perhaps the Legislature will stop following Brown's lead
and recognize that UC is a jewel worth preserving.

The San Francisco Chronicle runs an article about some new changes in the initiative process taking effect next year. California adopted its system of "direct democracy" in 1911 under reformist Governor Hiram Johnson (shown in photo) and it has been seldom modified since. Johnson was easily the most influential governor California has ever had, because of that electoral change - which also included women's suffrage in the state.

The new procedures basically allow a legislative intervention - essentially public hearings and negotiations with an initiative's sponsors, before the initiative goes on the ballot. Although the changes make it marginally easier to get something on the ballot by extending the time deadline, in reality it is still likely to cost a sponsor a million dollars or more to hire signature gathering firms.

If you look ahead to topics that might be put on the ballot, it is at least possible that proponents of further public pension changes could gather enough funds to make another effort. The main UC interest in such an event would be to prevent its pension from being swept into some all-encompassing proposition that would cover other state plans such as CalPERS and CalSTRS in local plans. Having a public hearing might allow an opportunity to work out a deal.

The SF Chronicle article:The measure opens the way for increased collaboration between lawmakers
and backers of initiatives by requiring the Legislature to hold a joint
public hearing on a proposed initiative as soon as 25 percent of the
required signatures are collected. It also calls for the attorney
general to open a 30-day public review before approving an initiative
for circulation and lets supporters amend the initiative during that
time... The review period also would give citizens a chance to weigh in on a
proposed initiative, suggesting ways to improve the wording, pointing
out potential legal problems, and proposing changes the initiative’s
backers could accept or reject... The new law also ensures that those legislative hearings can actually
mean something, since it allows backers to withdraw an initiative up to
131 days before the election. If a compromise can be worked out with the backers of
the initiative, right up to that ballot qualification deadline, the
measure can be pulled from the ballot...

Blog readers since yesterday may have noted an oddity in the way the blog looks. When you click on the general web address for the blog, you see only the most recent postings ending Dec. 28 rather than the usual full blog roll (with previous postings below the Dec. 28). This anomaly appears only to occur in the December postings. If you click on November (scrolling down the right-hand side where postings are listed by month), the anomaly doesn't appear. But you can still see all the December postings - not just back to Dec. 28 - by clicking on them one at a time, again scrolling down the right-hand side. (If you are on a mobile device, you will have to go into the web view to do the scrolling.) Yours truly has a dim memory of this problem arising before and (again dimly) recalls it going away. So if this posting makes no sense to you and everything looks normal, it probably means that the anomaly has died and gone to tech heaven.

Sunday, December 28, 2014

On Friday, we speculated on some possibilities for the state budget and the governor's conflict with UC prez Napolitano and the Regents over their tuition/state funding plan for UC. But to be truthful, the only safe prediction is that the governor will deliver his fiscal message using charts, since he has shown a past penchant for doing so when it comes to the budget. In that spirit, while we wait for real news, we'll put our cards on the the table
and offer the following: